Question

A.	ClassCo sells Convertible Bond with warrant to convert into stock
		Bond with face	$1,000
		Face Rate	8.00%
		Term	3	Yrs.
		Market rate @ sale	8.50%
		issued:	30/06/18
		maturity	30/06/21
		Interest paid annually
		Bond sold for	996.00
	1. determine value received from sale, Discount or Premium?
	2. Prepare JE to record sale, use incremental
		assume value of Bond in the known
		and value of warrant is incremental
B.	ClassCo:		PE 12/31/2018		Fiscal = calendar Yr.
		Net income: after tax	2000			shares:
					Beginning:	505
					3/1 issue	50
					9/1 issue	60
					Treasury Purchase 10/30	(24)
					on 11/22, 3 for 1 split
					Preferred dividends this year =	250
	1. Calculate EPS
	2. using "as if" compute EPS & dilutive effect of Convertible Bonds
	issued 10 bonds , $1000 bonds issued prior yr., 6%, each bond was convertible into 30 shares
		40% tax rate for bonds
C.		NET Income:	4500		No preferred stock
		Average # of Shares	2200		EPS =	2.045
		Stock Options:	all full Yr.
		# option shares	500
		0ption price per share	$18
		Market at PE being measured	$32
		Compute dilutive effect per share Please use excel to comple it					pl

Answer 1

A.

The details of no. of warrants for the bonds are not given and it is given that the warrants are incremental.

Since, both the stated rate of interest (or) nominal rate of interest; and the market rate of interest both are given, it is easy for us to compute the effective price of the bond individually.

Annuity factor for 3 years @ 8.5% is, 2.5540;

Present Value @ 8.5% at the end of 3rd year is 0.7829.

Effective Price of the Bond (standalone) = $1,000 x 8% x 2.5540 + $1,000 x 0.7829

= $782.908 + $204.322

= $987.23

The price of the bond alone is $987.23; and since the market rate of interest is greater than the stated rate of interest, it is clear that the bond stand alone would be sold at discount and by comparing the effective price of the bond with the face value, the discount on issue of the bond would be $12.77 ($1,000 - $987.23)

Since the warrants are incremental in value, we can find the amount attributed to warrants by deducting the effective price of the bond from the amount received for the bond by the company.

Value of warrants = $996 - $987.23 = $8.77

With the above the information, the given questions are answered as follows:

1. The value received from sale is $996; Discount on issue of Bonds is $12.77; Value of warrants is $8.77 and the face of bonds is $1,000

2. Journal Entry to record the sale is as follows:

____________________________________________________________

B.

In the given case, there are several issues of common stock and repurchase of stock as treasury stock, and even the stock split.

That is analysed in the following table:

We have taken the time weights for each transaction and we got the weighted average number of shares of common stock at the year end as 1,688.

Net Income after tax is given as $2,000;

Preferred dividends of the year - $250

With the above information, the given questions can be answered as follows:

1. EPS:

Earning per share is calculated by dividing the Earnings attributable to common shareholders by the weighted average number of shares outstanding

= ($2,000 - $250) 1,688

= $1.0367

= $1.04 per share

2. Diluted EPS & Dilutive effect:

If 10 6% convertible bonds of $1,000 are converted into shares, the company need not pay the interest it is been paying on them.

Interest net of tax that would be saved is = $1,000 x 10 x 6% x (100%-40%)

= $360

Therefore, if the bonds are converted, there would be an increase of $360 in the earnings of the common shareholders.

The number of common shareholders would also increase by the number of common shares converted = 10 x 30 = 300 shares at the beginning of the year;

due to stock split at 11/22 , the shares would become 300 x 3 = 900

The new earnings attributable to equity share holders = $ 2,110

The new weighted average number of common shares = 1,688 + 900 = 2,588

Diluted EPS = $2,110 2,588

= 0.8153

= 0.81 per share

Since the Diluted EPS is less than the Basic EPS, the convertible bonds are dilutive. Dilutive effect per share = $1.04 - $0.81 = $0.23

_________________________________________________________________

C. Net Income = $4,500;

Average Number of shares = 2,200

EPS = $2.045 per share;

Number of option shares = 500;

Number of shares issued at Zero cost = 500 - 500 x (1832) = 218.75

Diluted EPS = $4,500 (2,200 + 218.75)

= $4,500 2,418.75

= $1.86

Dilutive effect per share = $2.045 - $1.86 = $0.185

.

Hope this is helpful!!